Summary of WP/92/97
“Fiscal Policy in Pakistan Since 1970” by Nadeem U. Hague and Peter J. Montiel
Like many other developing countries, Pakistan adopted a policy in the 1970s that had the effect of expanding the role of the public sector over the medium term. This expansion, combined with the Government’s difficulties in raising fiscal revenues, resulted in overall fiscal deficits during much of the period 1970 to 1990 that were high in relation to the size of the economy. During this period, the ready availability of external finance at concessionary rates, as well as an elastic supply of domestic nonbank finance at less-than-world-market rates of return, mitigated the adverse effects of these high fiscal deficits. In this paper, it is argued that, although the use of concessional external financing may have moderated the inflationary consequences of fiscal deficits, this result was achieved at the expense of some crowding out of private investment and thus implied slower growth than would otherwise have been observed. Controlling the overall fiscal deficit during this period would have contributed to more favorable macroeconomic outcomes--at least with respect to growth and the external accounts --provided this had been done without reducing development spending.
Because of the high level of outstanding debt and limits on the availability of concessional financing, fiscal adjustment is likely to remain an important policy concern in Pakistan. The analysis indicates that debt-servicing costs alone could increase the overall fiscal deficit significantly, assuming that the additional debt required to finance future primary deficits was floated at market rates.
Fiscal deficit reduction in Pakistan may also have become more important in recent years because the comprehensive measures taken to remove trade and exchange restrictions (including the reduction of the negative import list and the removal of restrictions on capital flows and foreign currency holdings by domestic residents) are likely to have reduced the potential for collecting an inflation tax. Of three alternative policies for fiscal deficit reduction--reducing government current expenditures, reducing government investment expenditures, and increasing taxation-- the simulation model used in this paper suggests that a reduction of government investment would be least desirable in terms of output growth and inflation objectives. The most favorable growth and inflation outcomes result from a policy of limiting government current consumption. In reality, however, a combination of current expenditure control and revenue enhancements might be the most desirable policy choice to achieve a lasting fiscal adjustment for the 1990s.